"European power markets are being split apart by political fickleness"

February 7, 2013 | 00:00

Bert den Ouden, CEO of APX-Endex, the Amsterdam-based gas and power exchange raises the alarm: power prices in North West European markets are diverging for the first time in years. This means that markets are becoming more fragmented again instead of more integrated - in contradiction to what EU internal market policy is all about. According to ...

"European power markets are being split apart by political fickleness"

By Karel Beckman

Bert den Ouden, CEO of APX-Endex, the Amsterdam-based gas and power exchange raises the alarm: power prices in North West European markets are diverging for the first time in years. This means that markets are becoming more fragmented again instead of more integrated - in contradiction to what EU internal market policy is all about. According to Den Ouden, this development is the result of political decisions. "As a result of their unilateral and inconsistent policies, policymakers are splitting up markets faster than network operators and power exchanges can tie them together which can potentially be detrimental to end-users." Den Ouden calls on policymakers to agree to an "EU Energy Stability Pact" that would at least compel national governments to take into account the effects of their measures on their neighbours.

Bert den Ouden, CEO of APX-Endex (c) businessreviewbrasil.com

No doubt it was the mother of all unilateral decisions: Germany's abrupt closing down of its nuclear power plant park in the spring of 2011. It was likely one of the major reasons for a trend that has started last year: a slow but steady divergence of prices in the French, German and Benelux power markets.

Starting in the last quarter of 2006, when the French, Dutch and Belgian power markets were coupled, a process of steady price convergence began in North Western Europe. In 2010, when the integrated trading area was created together with Germany and Luxemburg into what was called the Central West European (CWE) "pentalateral coupling", overall price convergence reached 80% on average. Before 2006, it had been close to zero.

In an interview with EER in September 2010, Bert den Ouden - who has led the Amsterdam-based power and gas exchange APX-Endex since its inception in 1999 and who is one of the architects of the market coupling process - was elated. "The integration of the European electricity market will transform the European economy", he said. "The old ideal of one European copper plate is rapidly coming within reach. With highly beneficial consequences for European consumers and producers. It means more efficiency for everybody. An optimal use of generation and transmission capacity in Europe. And a crucial stimulus for the large-scale use of renewable energy."

Fast-forward to January 2013, and we find that the promise of price convergence, although still beckoning, is now reversing course. Over 2011 and 2012, overall price convergence actually started going steadily down - to less than 50% at this moment. This means that half of the time prices between two or more of the North West European markets differ.

Why is this important? Price convergence, explains Den Ouden, shows that markets are integrated, that there is full competition among suppliers and that users get the best price. In other words, it shows that scarce resources are used in the most efficient way. Price divergence, on the other hand, is a sign that generation resources are not used at full economic efficiency and that users cannot make use of the best offers.

So what kind of money are we talking about that is being wasted? No one really knows, says Den Ouden. "It is certainly something that should be researched. I invite researchers and institutions to undertake this task. To find out what the loss is to society. Every time prices diverge, there is a loss of wealth. There is a reason, you know, why we want to have a single market!"

Crazy

The trend observed by Den Ouden - to which he first called public attention at the Emart conference in November 2012 in Amsterdam - is caused, he says, by political, not economic, decisions. "It is caused by the fact that countries are making their own decisions in energy markets, sometimes for understandable political reasons, but they are not necessarily the most efficient decisions from a broader market perspective. If you let the market do the work, and if you have sufficient interconnection, investments will go to the best places. Prices will sort themselves out. But if each country takes its own decisions, the market will be distorted."

This market distortion can come at cost to the consumers, Den Ouden stresses. The different nuclear

"You close nuclear power stations in Germany and you build them up again in the UK - all at very high cost. For individual member states such decisions may make sense for political reasons. From an overall European point of view, it's irrational.

policies in EU countries are a case in point. "You close nuclear power stations in Germany and you build them up again in the UK - all at very high cost. For individual member states such decisions may make sense for political reasons. From an overall European point of view, it's irrational. They wouldn't do this in the US. People from outside Europe will say it's crazy. It certainly is very costly. We could have used this money so much better, for instance for additional investments in CO2 reduction."

The differences in nuclear and renewable energy policies have led to an increase in price differences between France and Germany, notes Den Ouden. "German prices are now more fuel-driven, dependent on the cost of coal and gas. They are also more weather-driven, since the Germans have a lot of wind and solar power." And the Dutch system differs as well: with fuel-efficient generation but little nuclear or renewables, it is much less wheather-driven than the others but even more fuel price dependent. The divergence between all these policies is widening. We need to converge.

The huge build-up of renewable power capacity, concentrated in Germany, thanks to massive subsidies, is another prime example of different national policies that have major consequences for the European market. Den Ouden: "It would not be such a problem if this renewable capacity was more evenly spread throughout Europe. But it is not. Now the electricity systems in for instance in Eastern Europe are regularly rocked by the loop flows that go from North to South Germany. So much so that these countries sometimes cannot use their grids enough for their local needs and cross-border flows between each other.

Den Ouden points out that if "the subsidy competition" in the renewable energy sector (in the sense that each EU country has its own renewable energy policies), is continued in its present form, this will become another waste of public money. "Applause for the support for solar so far, but Germany is not the sunniest country in Europe. A better balance, more spread across Europe, would be less costly and also reduce overload situations."

Fragmentation

Could the problem be solved by pushing market integration even further? Den Ouden, with his large experience in the CWE market coupling development, says this is possible to some extent. "We are taking further steps with other exchanges and TSOs, such as flow-based market coupling and PCR (Price Coupling of Regions). We are working very hard towards implementation. These initiatives will help to improve price convergence again.But we cannot work miracles. We will get near to the ultimate physical limits of 100% secure capacity utilization within the infrastructure."

In theory the divergence problem could also be tackled by building more interconnections between

In theory the divergence problem could also be tackled by building more interconnections between countries

countries. That's certainly needed, says Den Ouden, but there are two issues with that. First, it is costly. Second, it can't be done fast enough. "Building interconnections is a very slow, complex process. It can't be done quickly enough to keep up with political decisions. And if you do build interconnections, there is a chance that the political decisions will be reversed. It's impossible to plan properly and efficiently in this kind of environment."

With markets increasingly fragmenting again, national policymakers find themselves forced to take measures to ensure security of supply, but that at the same time may lead to even more fragmentation. Thus, many countries are now contemplating setting up national "capacity markets" to cope with the strong increases of intermittent (unreliable) renewable energy production in combination with limited interconnection.

In its most recent Communication on the Internal Energy Market, in November 2012, the European Commission raised the alarm about this proliferation of plans for national capacity markets. Brussels points out that this is - again - a very costly solution that will introduce even more market distortions. In a recent interview with EER, Philip Lowe, Director-General for Energy at the European Commission, made a strong plea against national capacity schemes. "If you're going to have a capacity mechanism probably the worst thing you can do is to arrange it nationally, without assessing import flows", he said. The UK government, however, in December announced that it remains intent on setting up a national capacity market.

Den Ouden is of the same opinion as Philip Lowe in this. "It is the next threat to the internal market. A capacity market is alright if it is done on a European basis. But if it is done on a national basis, it may well lead to an unlevel playing field. You will in effect get national subsidies." Den Ouden is not convinced that capacity markets are even necessary in most cases. "There is a capacity problem in the south of Germany, yes, but that has been artificially created. Experiences in the Netherlands and Scandinavia show that the market is perfectly able to guarantee security of supply."

Den Ouden finds himself increasingly amazed by the way things are going in the European electricity market. "We are pushed very hard by the authorities in order to integrate and supposedly move toward a single European market in 2014, while at the same time all sorts of measures are being taken that are fragmenting the market. I won't criticize any political decision as such. What I do criticize are the inconsistencies in space and time. They lead - am I repeating myself? - to substantial costs. The taxpayer and end user have to pay the bill."

Playing with fire

The "fickleness" of political decision-making has led to uncertainty among investors, with the result that investment in the sector is lagging. Den Ouden: "How can you plan and invest when policies can change 180 degrees in a few years' time? It is this rather than anything else that is endangering our security of supply."

The situation has become so risky that the south of Germany - now free of nuclear power - came very close to a general blackout in February 2012. This was caused by French power demand skyrocketing

The energy situation may not be quite as bad as the eurozone crisis, but Den Ouden does see parallels

because of the cold weather. "France is building more electrical heating systems every year", says Den Ouden. "If you have a cold day, France is pulling on the entire North West European power system which is becoming increasingly dependent on wind and solar. And you cannot solve this kind of problem with more interconnections, not on this timescale. Politicians realise this insufficiently. They actually shrugged off the problems in February. Do the lights have to go out before they realize this?"

The energy situation may not be quite as bad as the eurozone crisis, but Den Ouden does see parallels. That is why he makes a plea for an"Energy Stability Pact". Although the Treaty of Lisbon assigns to the EU the task of "ensuring the functioning of the energy market", it also states that each Member State has a "right to determine the conditions for exploiting its energy resources, its choice between different energy sources and the general structure of its energy supply."

Den Ouden does not necessarily want to change this provision. Rather what he proposes is to make it obligatory on Member States to make timely announcement of decisions in energy policy that may have a significant impact on other Members. "If countries do things, they ought to do them gradually and give their neighbours - and the energy sector - enough time to respond and adjust." This, he says, would improve the investment climate in the energy sector considerably. "If we really want one market, we should have the discipline to take decisions in better harmony."

If the Member States do not succeed in harmonising their energy decisions, the results would be costly for certain, and in the worst case possibly disastrous, concludes Den Ouden - as the situation in Germany in February of last year showed. "I do wonder sometimes: are we playing with fire?"

Bert den Ouden: a friend of the market

Bert den Ouden's call for more consensus in energy policy is not a lobbying effort: "trading on the APX-Endex is going very well, thank you. Our business is doing great."

Asked whether Europe should do more to develop its unconventioal gas reserves, the CEO of APX Endex says that "we should look to other parts of the world. Everybody is doing it, or wants to do it. You have to ask yourself, are we so smart or so stupid that we do so little about shale gas? The US is reducing its CO2 emissions at very low cost and is re-industrialising on the basis of cheap gas. I think developing shale gas could give a great boost to renewable energy. You create a lot of flexibility that way, it's a fantastic combination."

About emission trading, Den Ouden says this is unlikely to be effective for CO2 reduction as long as it is done on the basis of the current implementation of the cap and trade system. "Countries with fast-growing economies like India and China will not accept a cap. And countries with slow growth (currenly in Europe) have no problem staying within the cap. So it doesn't workat the moment." Instead of cap and trade, Den Ouden proposes to look at other alternatives like a CO2 effiency model, in which emission credits are allocated on the basis of efficiency benchmarks (amount of CO2 emitted per kWh produced) - an idea that has earlier been put forward by the Dutch industrial company DSM.

For example, a gas turbine with an efficiency of 60% would not have to buy credits, any turbine with lower efficiency,would. "This may be much more acceptable world-wide, for jnstanceto countries like India and China, because you can make these decisions everywhere irrespective of your economic growth. If we had adopted such a system, the CO2 price would also have been much less volatile." Den Ouden admits that Brussels has never been very receptive to this idea. "But times may have changed. The present system is not working well, so why not consider alternatives?" For example, another alternative is to correct the emission ceilings for economic growth, or lack thereof.

In the European electricity market, Den Ouden sees a strong trend towards decentralised generation and smart grids. "There is a deep-seated desire among people to be more independent and to use small-scale technologies, such as heat pumps, micro-CHP and solar panels." As an exchange, APX Endex will try to facilitate local power producers by offering them products such as "peak shaving" and "valley filling", says Den Ouden. An example of the former is to decrease flexible consumption when prices are high. An example of the latter is to use power, e.g. to charge electric car batteries, when prices are low. "You need local parties to make this work. We have already integrated such systems into the European market coupling algorithm. Now we are introducing them into our trading system. Cooperatives can make use of this if they want to. They tend to be very price-conscious, so I see real opportunities there."

Den Ouden is convinced that if there had been no liberalisation of the market, local initiatives and techologies such as the high-efficiency boiler would not have gotten off the ground. "The cooperatives and renewable energy supporters tend to be friends of the market."